"I'm Not Dead Yet"

The Iraq war and 9/11 have passengers skittish. Severe acute respiratory syndrome (SARS) is hurting travel to Asia. The Bush administration isn't in of a mind to be giving corporate handouts just now.

It hardly seems that anything else could go wrong for the US airline industry. Yet, in less than a week, airline executives have a lot less reason to be gloomy. There's even an emerging sense that most, if not all, of the major US carriers may survive the industry's ongoing crisis, albeit in a weakened financial condition.

Prozac, Anyone?

What's behind the sudden mood swing?

US Airways Group emerged from bankruptcy protection last week. American Airlines reached dramatic cost-cutting deals with its unions, averting an imminent bankruptcy filing. And on Friday, United Airlines reached a six-year, $1.8 billion concession package with its flight attendants' union, adding to the six-year, $6.6 billion in concessions agreed to by its pilots' union in late March.

All of that is good news for consumers because more airlines criss-crossing the skies means lower fares. But it won't solve what many experts say is the biggest problem facing airlines and their shareholders: too many seats chasing too few passengers.

Ever since United sought Chapter 11 protection in December, many of its competitors have argued the solution to the industry's woes is for United, the nation's second-largest carrier, to go away.Gordon Bethune, chief executive of Continental Airlines Inc., has been one of the loudest proponents of a United liquidation. Last week, he renewed his call for a smaller industry.

A 15 percent reduction in capacity would be about right, Bethune told CNBC Wednesday. "That would be one less airline," he said, not naming any names. The folks at United knew whom he was talking about anyway. United has a 17 percent market share.

Now some experts are suggesting the answer to the industry's problems may take a less radical form. While conceding the need for consolidation, Jurgen Weber, the outgoing chairman of German carrier Lufthansa, says, "You can do it in two ways. You can reduce the number of airlines or you can reduce the capacity within each."

Door Number Two, Please, Monty

The second option is better by far, he says, because putting a major carrier out of business likely would leave one or more major hubs deserted and certain parts of the country underserved by carriers.

Aviation consultant Michael Boyd agrees: "It's absolutely better if they all survive. We need as many carriers as possible. If United goes away, there will be markets with much less service or no service at all."

Getting smaller is something the nation's airlines have become adept at. Before Sept. 11, American and TWA, which it acquired in April 2001, offered a combined 3,300 daily departures. Today, the airline flies 700 fewer flights a day, a 21 percent reduction.

In the same time frame, United has cut its daily departures 34 percent, to 1,574 from 2,400. The bottom-line: Customers no longer have the same amount of choices they once did. And many second-tier cities are now served by regional jets. The tradeoff: Airfares are really low, and there's less congestion at some major airports.

The Shape Of Things To Come

Several experts and economists say it's too soon to predict the shape of the airline industry after it flies through the current crisis. But all this pain may end up being a good thing, says Carl Tannenbaum, chief economist with Chicago's LaSalle Bank.

"It's easy to be an armchair quarterback when you don't work for an airline or own an airline," Tannenbaum says, "but the hope is the airline industry we will have two years from now will be more to the satisfaction of the groups that depend on it."

Airlines are restructuring their routes. Outdated work rules accrued over decades are being dropped from contracts, and airline executives are fiendish about cost-cutting, he notes. "There have been many times in the past 20 years that it looked very dire for the economy as a whole or particular industries," Tannenbaum said. "But one thing that has always impressed me is that American companies are very resilient and adaptable. We are able to go through transitions so our corporations, workers and operations remain as efficient as possible."

The alternative--protecting industries from change--means ending up like Japan, dragging its banking crisis out over decades, he says. Others aren't nearly so optimistic about the outcome. They say everything hangs in the balance, and much of it depends on how a war is going halfway around the world.

"If you believe that this war is over by the end of the week, then the conclusion is that United doesn't liquidate and American doesn't go into Chapter 11," says John Pincavage, a Westport, Conn.-based financial adviser to airlines.

It's All A Matter Of Timing

"But if this thing goes on for four weeks, you come to a completely different conclusion. Or if an aircraft gets shot down by a missile. Or if the SARS panic spreads. There are five or six things the airlines have no control over that, if continued for an extended period, keep scaring away traffic."

One thing airlines do have some control over is their labor costs, and these days it's a race to the bottom. US Airways, which had the industry's highest costs for much of the 1990s, won wage concessions from its unions during its bankruptcy proceedings. It now projects its 2003 cost per available seat-mile, excluding fuel, at 10.5 cents, 14 percent lower than before its Chapter 11 filing last August.

American Airlines reduced its costs, including fuel, by 2.6 percent last year to 10.8 cents per seat-mile. It reshuffled flights at hubs in Chicago and Dallas to spread them more evenly throughout the day, and it automated customer check-in. Total savings: $2 billion. Now American has tentative deals to reduce labor expenses by almost another $2 billion. Its long-term goal: get its costs down to within 30 percent of Southwest's.

United, where costs soared in the past several years, is shooting for "best in class" costs, according to Chief Executive Glenn Tilton. Translation: in the ballpark with Southwest.

There's a long way to go. Southwest's cost per seat-mile last year, including fuel, was 7.4 cents. United's was 11.3 cents, a 35 percent difference.

Still, if United succeeds in winning the $2.56 billion in labor savings from its unions as well as $1.8 billion in non-labor savings, its overall costs would drop by more than 25 percent. Not all of the non-labor costs would translate into lower seat-mile costs, but some would.

If the labor savings and half the non-labor savings were in place last year, United's costs would have been 19 percent lower, or 9.2 cents per seat-mile, a big step in the right direction.

But You Can Only Cut So Much

While the industry will undoubtedly emerge leaner and meaner, some experts warn that getting costs down isn't enough to ensure long-term success. United and other mainline carriers will always have higher structural costs than discount carriers because they operate from more expensive hub airports and have more complex fleets. So they have to offer customers a better experience, whether that means in-flight meals, advance seat reservations or first-class upgrades.

Financial adviser Pincavage worries that in their efforts to cut costs, mainline carriers have gutted their service advantages as well. "Why do I want to fly these guys if price has become the only determinant of selection," he wonders. "Airlines are doing the obvious stuff from a tactical standpoint, but I don't see any of them doing something from a strategic sense. I don't see those kind of decisions being made. "Why not go back to brand-building?"

FMI: www.air-transport.org